903 F.

2d 784

The SHOSHONE INDIAN TRIBE and The Arapahoe Indian

Tribe, of
the Wind River Indian Reservation, Plaintiffs-Appellees,
v.
Donald P. HODEL, Secretary of the Interior, Department of
the Interior, Defendant-Appellee,
Atlantic Richfield Company, Defendant-Appellant,
and
Chevron Oil Company; Continental Oil Company; Shell Oil
Company, Defendants.
No. 88-2304.

United States Court of Appeals,

Tenth Circuit.
May 17, 1990.

Morris R. Massey of Brown & Drew, Casper, Wyo., for defendantappellant.

Robert S. Thompson, III (Sandra Hansen with him, on the brief) of
Whiteing, Thompson & White, Boulder, Colorado and Susan M. Williams
(Catherine Baker Stetson with her, on the brief) of Gover, Stetson,
Williams & West, Albuquerque, N.M., for plaintiffs-appellees.
Michael J. Malmquist (Roger J. Marzulla, Asst. Atty. Gen., Robert L.
Klarquist of the Dept. of Justice and Thornton Withers Field of the Office
of the Sol., Dept. of the Interior, Washington, D.C., with him, on the
brief), for defendant-appellee.

Before HOLLOWAY, Chief Judge, McWILLIAMS, Circuit Judge, and

BABCOCK, District Judge.*

BABCOCK, District Judge.

Atlantic Richfield Company (ARCO) appeals the final partial summary

judgment entered in favor of the Secretary of the Interior (Secretary) and the
Shoshone and Arapaho Indian Tribes (Tribes). The judgment upheld audit
results prepared by the Mineral Management Service (MMS) disallowing
certain deductions claimed by ARCO which had reduced ARCO's royalty
payments to the Tribes from wet gas (gas which is rich in natural gas liquids)
produced from leased tribal land. In doing so, ARCO was ordered to pay
additional royalties of $37,937.20 for 16 sample months and to compute and
pay additional royalties for 80 remaining months in accordance with the MMS
audit. We affirm.

I. Facts
4

This action was brought by the Tribes against the Secretary and several oil
companies that had mineral leases on tribal lands. The Tribes, owners in
common of the minerals under the tribal lands, claimed that the oil companies
had underpaid royalties due on gas produced and sold from the Wind River
Indian Reservation. Defendants Chevron Oil Company, Continental Oil
Company and Shell Oil Company are not involved in this appeal. The Secretary
applied the "net realization" method to calculate the royalties due. That method
requires ARCO to pay royalties based on the value of the residue gas and
liquids after processing, minus a processing allowance.

In response to the complaint and correspondence from the Tribes, the MMS, a
subdivision of the Department of the Interior, initiated an audit of the gas
companies' leases with the Tribes, including the ARCO leases, to identify any
royalty underpayment. Before the audit was completed, ARCO, the other
defendants and the Secretary stipulated that:

6 unresolved issues raised or to be raised by the [MMS] in its audits of royalty

all
payments on natural gas and liquid products produced from the Wind River Indian
Reservation leases which are the subject of this action shall be determined by this
court [the district court] without the necessity of intervening administrative appeals.
7

After reviewing ACRO's comments, conducting an on-site inspection of

ARCO's River Dome Gas Plant (RDGP) and surveying ARCO's previously
filed royalty calculations, the MMS determined that several of ARCO's claimed
cost deductions were improper. ARCO does not claim that there was any
procedural error by MMS nor does ARCO raise any constitutional challenges.
Rather, ARCO challenges the MMS conclusion that two cost items were
nondeductible. Both cost items pertain only to the RDGP. First, ARCO
contends that the MMS audit was wrong in disallowing ARCO's deduction for

the cost of gas compression required both to manufacture and market the gas.
Second, ARCO contends that the MMS audit was wrong in disallowing
ARCO's deduction of a flat 10% of its allowable processing deductions to cover
administrative overhead costs. Instead MMS required ARCO to specify and
verify those expenses.
8

There being no material factual dispute, the controversy was submitted to the
district court on cross-motions for summary judgment. The district judge
granted the Tribes' and the Secretary's cross-motion and denied ARCO's crossmotion.

II. Standard of Review

9

ARCO contends that the district court should have reviewed the decision of the
MMS de novo. We disagree.

10

ARCO and the Secretary stipulated that any MMS audit findings which ARCO
disputed would be resolved by the district court without the need for exhaustive
administrative appeals. Had the parties proceeded through the administrative
process to the district court, the district court would have reviewed the decision
under the standard of review for final administrative actions. 5 U.S.C. Sec.
706(2)(A). The stipulation, short-cutting the administrative process, does not
change the standard of review. Accordingly, in affirming the determinations of
the MMS because they were not "arbitrary, capricious, an abuse of discretion,
or otherwise not in accordance with law," the district court applied the correct
standard of review.

11

That the issue was raised on a motion for summary judgment does not alter the
standard of review. There being no material factual question in dispute, the
court correctly addressed the questions of law under the administrative standard
of review.III. Disputed Cost Deductions

12

Our inquiry is under the same standard as that of the district court. We look to
see whether the district court concluded correctly that the MMS judgment was
not arbitrary, capricious, an abuse of discretion or contrary to law. See
Marathon Oil Co. v. United States, 807 F.2d 759, 765 (9th Cir.1986), cert.
denied, 480 U.S. 940, 107 S.Ct. 1593, 94 L.Ed.2d 782 (1987). We also note
that the interpretation given by MMS to the applicable royalty and deduction
regulations is entitled to "controlling weight unless it is plainly erroneous or
inconsistent with the regulation[s]." Udall v. Tallman, 380 U.S. 1, 16-17, 85
S.Ct. 792, 801, 13 L.Ed.2d 616 (1965) (quoting Bowles v. Seminole Rock &

Sand Co., 325 U.S. 410, 414, 65 S.Ct. 1215, 1217, 89 L.Ed. 1700 (1945));
Wilder v. Prokop, 846 F.2d 613, 619 (10th Cir.1988). This deferential treatment
to the administrative interpretation is lessened when the interpretation is
inconsistent with the intent of the drafters, the plain language of the regulation
or prior administrative interpretations. United Trans. Union v. Dole, 797 F.2d
823, 829 (10th Cir.1986).
A. Statutory and Regulatory Provisions
13

The Indian Mineral Leasing Act of 1938, 25 U.S.C. Sec. 396 permits Indian
tribes to grant mineral leases on tribal land with the permission of the Secretary
of the Interior. The Secretary is delegated the authority to define the terms of
the leases and to "make such rules and regulations as may be necessary for the
purpose of carrying the provisions of [the] section into full force and effect...."
The Secretary has exercised this authority both by drafting provisions in the
ARCO leases and promulgating regulations. We look to those provisions and
regulations to determine if the MMS acted arbitrarily, capriciously, with abuse
of discretion or contrary to law in denying ARCO's claimed deductions.

14

B. Deduction Credits against Royalty Payments

15

ARCO argues that the MMS erred in disallowing deductions for the costs
associated with its RDGP inlet compressors. ARCO also argues that the MMS
erred in disallowing a flat 10% of allowable processing deductions to cover
administrative costs. We address each objection individually.

1. Compression Costs in Manufacturing Allowance

16
17

Lease provision 3(c) provides that ARCO will pay a royalty based on the value
of gas produced from the leased land. In determining the value of the gas
produced, ARCO is permitted "a reasonable allowance for the cost of
manufacture...." The Secretary has also promulgated regulations allowing for
such a deduction. 30 C.F.R. Sec. 206.106(b) (1987). That regulation also
provides that "no allowance shall be made for boosting residue gas, or other
expenses incidental to marketing." Similarly, section V(A) of NTL-5, Notice to
Lessees and Operators of Federal and Indian Onshore Oil and Gas Leases, 42
Fed.Reg. 22610, 22611 (1977) (NTL-5 Notice), issued by the Secretary to
supplement the regulation, provides that marketing costs are nondeductible.

18

Finally, the U.S. Geological Survey, the predecessor to the MMS, provides
guidance in determining what ARCO manufacturing costs are deductible.

19
Allowable
investment costs are generally those expenditures for fixed assets
(including delivery and installation costs) that are directly associated with the
recovery of natural gas liquids. Most investment items are generally located within
the confines of the plant, beginning at the inlet of the plant and ending at the tailgate
of the plant, and shall be limited to those items which, in the judgment of the
Supervisor, are an integral part of the extraction process.
20

Geological Survey, Conservation Division Manual, Part 647.7.3(D) (May 10,

1974) (CDM).

21

The plain meaning of the above lease provision and regulations is to disallow
deduction of those expenditures related to marketing extracted gas.
Consequently, if it was reasonable under the lease and applicable regulations
for the MMS to conclude that the compressor costs were incidental to
marketing, then MMS did not act arbitrarily, capriciously, with abuse of
discretion or contrary to law in refusing to allow deduction of those costs.

22

The inlet compressors at issue are located in the RDGP facilities. Deposition
testimony of ARCO petroleum engineers established that they perform dual
functions. First, they increase the gas flow pressure within the plant allowing
for efficient processing of the gas stream, a manufacturing function. Second,
they increase the gas flow pressure to the level necessary to pass through the
pipeline and ultimately to the purchaser of the gas, a marketing function.

23

The MMS audit concluded that the inlet compressor costs were nondeductible.
Although the compressors serve a manufacturing function, the MMS
interpreted the regulations as disallowing deductions for costs associated with
marketing. This is not unreasonable.

24

First, manufacturing costs are deductible only if the Secretary determines that
they are an "integral part" of the manufacturing process. CDM, Part 647.7.3(D).
Thus, that determination is left to the discretion of the Secretary. Second, the
Secretary's regulation, found at 30 C.F.R. Sec. 206.106(b) (1987), explicitly
disallows deductions for costs incidental to marketing, as does section V(A) of
the NTL-5 Notice, also issued by the Secretary, and CDM, Part 647.7.3(D).
The interpretation by the MMS of these regulations does not conflict with their
plain meaning and there is nothing to indicate that it is contrary to the intent of
the regulations' drafter.

25

ARCO argues that the MMS judgment conflicts with prior administrative
interpretation. Essentially, ARCO contends that because it has submitted

royalty reports claiming deductions for the inlet compressor costs for the past
twenty years, and because the deductions have never been rejected as improper,
the MMS may not now change the long-standing rules of the game.
26

ARCO is correct that where an administrative agency interprets a regulation

consistently over a long period of time, publicly, and through careful and sound
reasoning, modifications of the interpretation should be scrutinized by the
courts. Skidmore v. Smith, 323 U.S. 134, 140, 65 S.Ct. 161, 164, 89 L.Ed. 124
(1944) (thorough, valid reasoning and consistency); Udall v. Tallman, 380 U.S.
1, 17-18, 85 S.Ct. 792, 801-02, 13 L.Ed.2d 616 (1965) (public record and
discussion). Until now however, ARCO royalty reports were never challenged.
This administrative acquiescence does not, therefore, rise to the level of longstanding policy.

2. Unverified Costs in Overhead Allowance

27

The Conservation Division manual provides that deductions for overhead costs
"shall be limited to ten percent of the other permitted operating and
maintenance costs." CDM, Part 647.7.3(E)(9). Further, the deductible
administrative costs "will generally be limited to those items which, in the
judgment of the Supervisor, are an integral part of the extraction process. Such
expenditures may be verified by requesting copies of the invoices." Id. at
647.3(E).

28

The MMS audit concluded that the overhead deduction can be as high as ten
percent of the other permissible operating and maintenance costs, but that the
overhead costs required verification. ARCO contends that this interpretation is
in error because ARCO should be permitted to deduct the ten percent overhead
allowance regardless of its ability to verify the costs. As its primary rationale,
ARCO argues that for the past twenty years it has successfully deducted the ten
percent without the need to verify costs and that, therefore, there is a long
standing policy of allowing such deductions. However, as discussed above, this
does not constitute a long standing policy. Furthermore, the MMS interpretation
is consistent with the regulations.

29

Because the judgment of the MMS is not arbitrary, capricious, an abuse of

discretion or contrary to law, we AFFIRM the judgment of the district court.

Honorable Lewis T. Babcock, United States District Judge for the District of
Colorado, sitting by designation